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The Civil War changed the country more than any other event in U.S. history, and its echoes are very much with us yet in many aspects of American life. Even the paper money we use every day is a consequence of the war.

The Civil War affected all areas of American finance. It turned Wall Street into the second-biggest financial market in the world. It brought the first income tax into being (and with it, the forerunner of the IRS). The national debt rose from a trivial $65 million in 1860 to $2.7 billion in 1866. But perhaps the most significant, and positive, financial change wrought by the Civil War was in the banking and monetary systems.

The attempt by Alexander Hamilton to give the new United States a coherent, well-regulated monetary and banking system was killed by the Jeffersonians in 1811, when the charter of the first Bank of the United States was not renewed. The bank had been the nation's central bank and chief borrowing agent. It also provided discipline to the burgeoning number of state-chartered banks by deciding whether or not to accept their bank notes. If the Bank of the United States wouldn't accept them, neither would any other bank.

Even bank notes from well-established banks tended to circulate at a discount proportional to the distance at which the transaction took place from the bank's headquarters.
Library of Congress

With the demise of the Bank of the United States, state banks proliferated, and even though a second Bank of the United States was chartered in 1816, it was never able to assert the same degree of control as its predecessor. Andrew Jackson vetoed its charter renewal in 1832, and the U.S. would be the only major country without a central bank for the next 80 years.

The number of state-chartered banks more than doubled in the two years after the first Bank of the United States lost its national charter. But many of them were so poorly capitalized (and, often, so badly regulated by state governments) that half the banks chartered between 1810 and 1820 had failed by 1825. Half of those founded in the 1830s had failed by 1845. But the net number of banks kept rising as the American economy expanded and the country pushed westward. There were about 1,000 banks in operation in 1840 and twice that many by the eve of the Civil War.

Many of them issued bank notes, and these were only as good as the ability of the issuing bank to redeem them for specie (gold and silver). By the 1850s there were thousands of issues of bank notes circulating. Some were sound, some were from defunct banks, and not a few were frauds and counterfeits.

Publishers began printing "bank-note detectors," which illustrated the various issues and assessed the worthiness of each. Even bank notes from well-established banks tended to circulate at a discount proportional to the distance at which the transaction took place from the bank's headquarters.

This chaotic money supply was, obviously, a serious drag on the economy. The Jeffersonian fear of large banks, however, along with the opposition of many state governments, prevented any reform. Then the Civil War changed the political equation. Most of the opposition to a strong banking system was in the South and West, and, of course, the South was then out of the Union.

Even more important was the fact that the federal government was desperate for money with which to finance the war. And federally chartered banks could be required to hold federal bonds.

So, 150 years ago this year, the national banking system was born. The National Banking Act established the Office of the Comptroller of the Currency and allowed the widespread chartering of national banks. These banks were closely regulated. They had to keep one-third of their paid-in capital in federal bonds and deposit these bonds with the Treasury, converting millions in bank capital into cash to finance the war.

The bonds also served as security for a new national currency. National banks were allowed to issue bank notes in proportion to their capital. But the bank notes, except for the name of the bank and the signatures of its officers, were all identical in design. The thousands of bank-note issues from state banks continued to circulate, but, in 1865, these notes were subjected to 10% federal excise tax, quickly driving them out of the marketplace.

For the first time, the United States had a uniform paper currency circulating throughout the country. Because these notes were backed by federal bonds held at the Treasury, they circulated at par.

The National Banking Act had been intended to create a unified American banking system under a single, federal regulatory regime. "The national banks were intended to supersede the state banks," Senator John Sherman, architect of the legislation, reported. "Both cannot exist together." Indeed, many state banks flocked to take national charters, and the number of state banks dwindled from 1,466 in 1863 to a mere 247 in 1868.

Unfortunately, not all of them did, or could, convert, being too small to meet national-bank capital requirements. The number of state banks began to increase again, most of them stand-alone, poorly capitalized institutions very vulnerable to local economic downturns. The collapse of thousands of them beginning in the 1920s was a significant part of the Great Depression.

Today, American paper money (now issued by the Federal Reserve) is backed by only the size and strength of the American economy. But it is accepted around the world.

JOHN STEELE GORDON is the author, most recently, of An Empire of Wealth: The Epic History of American Economic Power.